Definition of Mezzanine Lending
Mezzanine lending is a cross between equity and debt. It is a high-cost method of financing because lenders charge 20 percent, or more, because of the risk. If something bad were to happen at a company receiving mezzanine financing, the lender stands little chance of getting his money back because his loan is one of the last to be paid. Most often, mezzanine financing is only available to solid companies with a history of growth and predictable earnings.
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How Mezzanine Financing Works
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If a company that receives such financing falls behind on its payments or at the lender's option, lenders can convert all or part of the debt to shares of the company's stock at a price agreed upon ahead of time. The lender then has the chance to make a significant profit if the company's shares increase substantially in value. But the lender's interest in the company is not collateralized so his risk is substantial.
Who Makes Mezzanine Loans?
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Investors specialize in mezzanine financing and they include private investors, mutual funds, pension funds, financial institutions and insurance companies. Each are skilled in assessing the worth of companies and are willing to assume risk for the opportunity of making a huge profit on their investments.
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What's Involved?
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All mezzanine loans involve debt and equity in the form of shares of the company stock. Often, the loan is predicated on the company's ability to sell additional shares of stock and a warrant for the lender to convert part or all of the loan in accordance with the agreement. Most, not all, of mezzanine financing is made for four to eight years.
When Is Mezzanine Financing Used?
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Often, a company's management intends to make a leverage Bbuyout of the company; and in many cases, it won't have access to more traditional forms of financing such as from banks and other lenders. Assuming that the company is financially healthy, mezzanine financing makes a lot of sense because, at some point in the future, the new management will take the company public at which point those traditional lenders will provide permanent financing and the mezzanine lender will get his money back at a substantial profit.
Pluses And Minuses
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Mezzanine financing allows owners to operate their company, as long as it is profitable. If it falls on hard times, it can call on the expertise of the mezzanine lender to provide strategic assistance. Also, most mezzanine lenders aren't interested in making a quick profit, and the existence of such a loan tends to make the stock rise, not withstanding the depressing effect of the lender's right to a certain number of shares. On the negative side, the loan agreement may impose restrictions on how the money is to be spent. Also, mezzanine financing is expensive and the process of getting such a loan is burdensome.
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References
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